It’s been a wild and unprecedented ride for global stock markets. As of this writing, the S&P 500 is down 20% from its all-time highs set in late February 2020 — making this one of the fastest-ever corrections on record. Many individual stocks are down even more. Farewell bull market (though I’d argue it was short-lived anyway, since the market declined just a smidgen under 20% in the fourth quarter of 2018).
Granted, a pullback shouldn’t be surprising. Nevertheless, the reasons for it and the severity of the sell-off in recent weeks is. And to be sure, there are some reasons to be worried. Coronavirus started out as just another potentially worrisome illness — those constantly pop up as threats every year — but has spread into a pandemic that is sure to be at least a short-term weight on the global economy. The oil production war between Russia and Saudi Arabia isn’t going to help either, putting many heavily indebted and energy price-dependent U.S. shale producers (and owners of their debt) at risk.
But is it time to sell? By and large, for long-term investors the answer is no, especially if it’s fear-driven selling. At the very least, when unsure of what to do, the best course of action is often to sit on one’s hands and do nothing at all. As has played out countless times in history, this too shall pass. Even if stock prices continue to fall, they will eventually rally.
For those who can stomach it, adding to stock positions that have been long-term winners is an even better course of action (more on that in a minute). Same counsel as above: This too shall pass, and buying quality businesses when no one else will is a near surefire way to generating long-term profit.
That isn’t to say selling stocks is out of the question, though. Regardless of what kind of investor you are (retired in need of income, approaching retirement, or in no hurry to touch your savings), there are some scenarios that warrant pressing the “sell” button.
In need of some cash
First, if you are a retired or nearing-retirement investor, there’s a good chance you hold some stocks. If investment income is the goal, having a year or two worth of expected withdrawals from your account in cash or short-term investment equivalents is advisable.
If you already have two years or so worth of cash, I say no sweat (since the average bear market lasts a year or two, although they’ve been getting shorter in recent history). If not, it’s time to start liquidating some positions. But which ones?
Offloading the losers
When looking to sell stocks, I always start with my losers — those stocks that have underperformed (or outright lost value) during the last run-up in the stock market. If they continue to do poorly during a market rout, there’s a good chance the reason for ownership is broken and it’s time to part ways.
After all, a company that has fallen behind the competition when times are good is unlikely to make headway when the economy is under duress. There are of course exceptions to the rule, but in general, long-term losers keep losing, and long-term winners keep winning.
As an example, though I think (((( CenturyLink‘s NYSE:CTL) services still have great value, and the high-yield 9% dividend is currently well-covered, shares have grossly underperformed for years. Same goes for my stake in automakers Ford NYSE:F) and Tata Motors NYSE:TTM), which are facing mounting pressure from the move to electric vehicles and other transportation industry disruption, and my small allocation to the energy industry via the Vanguard Energy ETF NYSEMKT:VDE). It looks like time to part ways, at least for the time being until the longer-term investment thesis improves.
Re-allocating long-term gains to buy some value
In tandem with selling the losers, it might also be time to reduce exposure to the biggest winners, too. Over the course of the last 11 years since the financial crisis, some stocks have doubled in value many times over and far-outpaced the market overall. As a result, for some investors, companies like ((( Netflix NASDAQ:NFLX), Apple NASDAQ:AAPL), and Amazon NASDAQ:AMZN) have grown to represent a large portion of the portfolio overall.
I’m certainly not suggesting these big winners be sold off completely. As already discussed, if winners keep winning, then you’re best picks deserve to continue leading the way forward. However, in an effort to stay diversified, I tend to draw the line at about 5% to 7% of my total portfolio allocation to any one stock. If they’ve grown above that 5% to 7% mark, I start making small sales to reduce the position under that level.
This strategy accomplishes a few things:
- If you’re in need of cash, rebalancing big winners (and making fewer new purchases) does the trick.
- It also makes for a more well-rounded investment portfolio. While it’s natural for a small handful of companies to do most of the heavy lifting when it comes to total investment return, allowing one or two stocks to be responsible for heavy losses (should something go wrong with the business itself) isn’t acceptable.
- And, most importantly, rebalancing generates the liquidity needed to go shopping for undervalued high-quality stocks during bear markets. Those can be current stocks you own that have a proven track record, or new ones that have been on your wish list. Though painful, periods of economic stress can make strong companies even stronger. After severe selling, some of those companies are on steep discount and can be reallocated to with profits from other winners.
When to definitely not sell
Whatever the original reason for buying stocks, there is one reason to definitely not sell right now: You’ve changed your mind on stocks, or you feel that you can’t take the turbulence anymore.
Allow me to get anecdotal for a moment. In talking with hundreds of investors over the years, I’ve met far too many that lament they lost a great deal of money over a decade ago during the Great Recession of 2008-2009. A few claim they never recovered. When digging a little deeper, they all have one thing in common: They sold near market lows and got out of the game, opting instead for cash, equivalents, or some other asset class that was perceived as “lower risk” in the subsequent years following the financial fallout.
Let me be clear on one point: It’s OK to change investment strategy to reduce volatility, but the time to do so isn’t after the market tanks. Making big decisions isn’t the course of wisdom when emotions are running high. If the decision was to own stocks, review the original reasons why, and reflect on the possible outcomes for the market over the next year or two. History says a rebound will eventually occur. After that rebound will be the time to consider adjusting the strategy. As the old saying goes, “In for a penny, in for a pound.” I’d advise seeing the original decision through to better times.
Of course, every investors’ situation is different, so this is a rough guide (not a list of rules) as to when to sell and when not. But one thing is almost always true: Selling on emotion is a great way to sow seeds of future regret. Stay the course and try to tune out the tidal wave of bad news.